DVCMY - Remy Cointreau Hammered By Changing Tastes And Aggressive Pricing

2023-12-29 10:28:54 ET

Summary

• Remy Cointreau has been struggling due to weak demand for cognac and ongoing market share losses, particularly in the key U.S. market, and U.S. channel inventories remain too high.
• While many rivals are responding to pressures on consumer disposable income with pricing actions, Remy Cointreau management has been adamant that price cuts aren't on the table.
• A cost-cutting program for FY'24 makes sense in light of much weaker expected revenue, but cutting promotional spending seems ill-advised considering market share losses and high relative prices.
• Remy Cointreau's long-held valuation premium has basically vanished, but it's hard to call the shares "cheap" and a bullish thesis relies heavily on a strong FY'25 rebound in cognac sales.

It's been a rough couple of years for Remy Cointreau ( REMYY ) ( REMYF ) (RCO.PA), as this well-known manufacturer of high-end cognac has been hit hard by a combination of adverse consumer tastes (weak demand for cognac), price-driven trading down across the spirits market, and an arguably stubborn insistence on maintaining pricing to preserve long-term brand value. With that, not only has management guided to a high-teens organic sales decline in FY'24 (on weak depletions in the U.S. and weaker China demand), but the shares have fallen more than 40% since my last update on the company.

I'm still not that interested in these shares. While I'm a fan of some Remy Cointreau products and I don't think cognac is forever doomed as a category (drinker tastes can be trendier than commonly acknowledged), I do think it will be some time before the market is willing to once again pay anything like the premium it has given Remy shares in the past. To that end, while the shares aren't as egregiously expensive as before, I don't think they're a bargain and a weaker consumer economy in 2024 could still create some downside risk for sentiment.

A Less Desirable House In A Declining Neighborhood

The reasons can be debated (including a shift in the average age of drinkers, shifting tastes, and economic issues like affordability), but cognac is not doing well as a category and hasn't been for some time. While spirits overall have been taking share from beer and wine, cognac has seen barely any category volume growth and there is an established record here of down-trading during weaker economic times.

Most recently, cognac has been a real slide, with sales down around 6% to 9% depending upon the data source (NABCA, Nielsen, et al.), making it the worst-performing category in a market that is still showing low-to-mid single-digit growth.

Making matters worse, Remy Cointreau's management has been unwilling to budge on pricing, fearing that doing so would damage the brand over the long term. This is a fair point for the company's highest-end offerings, but the reality is that other players in cognac are taking a more flexible approach to pricing - not going back to pre-COVID prices but easing back a bit as input costs decline. With that, Remy's brands have collectively lost around two points of share, exacerbating a trend that goes back about a decade now (with Hennessy , co-owned by LVMH ( LVMUY ) and Diageo ( DEO ) gaining share).

Depletions Sapping Revenue And Earnings

With U.S. consumers turning away from cognac in general and Remy brands in particular (and the U.S. is far and away the company's largest cognac market), the business is struggling. Retailers, perhaps misled by trends during the pandemic and the desire to avoid unpopular out-of-stock situations, over-ordered, and with the falloff in demand there is now too much inventory in the U.S.

That, in turn, is leading to some ugly reported financials - the fiscal second quarter saw value depletions down 33% in the U.S. after a 5% drop in the prior quarter, and inventories are still too high at around five months (versus a target of four months). Sales in China have remained positive, but first-half sales of cognac declined 30% overall on an 18% decline in sales in the second quarter.

Given how profitable cognac is for the company, this is having a significant impact on overall earnings. Operating earnings declined 43% in the first half of the year, with cognac profits down 47% and margin down about 12 points to 35%. While sales of other Liqueurs & Spirits weren't especially strong (flat in the first half and up 12%) and earnings did decline modestly (down 4%, with margin down 0.2% to 14.7%), the cognac business generates almost five times the operating income of the L&S segment.

Making matters worse, there's no clear path to meaningfully better results in the short term.

Where once management was looking for basically stable revenue in FY'24 (and the Street was looking for a decline of around 5%), the weak second-quarter results led management to revise guidance to a 15% to 20% decline in revenue. Weakness in the U.S. is definitely the main driver of this, but I would also note that growth for China was revised from healthy double-digit growth to low-to-mid single-digit growth.

Management is looking to offset some of this revenue pressure with a broad cost-cutting program. While cutting back in some areas makes sense, I question the decision to pull back on marketing and advertising while also maintaining more aggressive pricing relative to rivals. It's certainly debatable how much advertising can shift preferences (if you don't drink cognac now, is a commercial going to convince you to try it?), but it's a decision that hasn't sat well with many analysts, though a recent sell-side meeting did see Remy Cointreau management state that they would be more "selective" on pricing until cognac volumes improve.

I also want to point out that management has publicly stated that they will honor their buying commitments for eau-de-vie. This will work against the company's cost-cutting efforts in the short term (particularly given volume/inventory trends), but given the long production process for cognac and the risk of alienating suppliers, I think this is actually a smart move for the long term.

The Outlook

The best recent incremental news for Remy Cointreau may well not involve Remy at all. I'm speaking of the recent announcement that Davide Campari ( DVCMY ) will buy the Courvoisier business from Beam Suntory for $1.2B and a potential $120M earn-out (a 35x multiple to the estimated 2023 EBITDA. While considerably smaller than Remy Cointreau's cognac business, Courvoisier is nevertheless one of the "big four" in cognac that controls about 85% of the market, and Campari management clearly believes there's still some future growth potential left in the cognac business.

An ugly FY'24 for Remy Cointreau is already well understood by the market, but a lot of uncertainty remains as to when inventories and depletions will stabilize and when the U.S. business will start growing again. Over the long term, the company could benefit from a maturing consumer base (as customer tastes mature from ready-to-drink products and other spirits to cognac), but a lot likely depends upon consumer spending and disposable income in the short term, and I'm not particularly excited about this.

Long term, I think Remy Cointreau can generate around 3% to 4% revenue growth, but management must show that they can rebuild brand value and regain share, particularly as I don't think cognac is likely to re-emerge as a growth category. That said, consumer preferences for spirits are trendier than commonly appreciated, and there was a time not so long ago when nobody would have believed that gin or tequila would be popular spirits again. In other words, I'm not bullish on cognac's relative popularity, but I know better than to write it off.

I do still expect this business to remain highly profitable, and I think there are opportunities for management to make some tuck-in M&A deals if they want to go that route and better leverage existing distribution channels. As is, I expect mid-teens free cash flow margins in five years (with operating income margin in the mid-to-high 20%s), with potential into the 20% range over time, leading to high single-digit FCF growth.

Remy Cointreau shares look roughly fairly-valued on the basis of discounted cash flow, and likewise only modestly undervalued on EV/EBITDA. I should note that the roughly 17x forward EBITDA multiple I use is below the stock's historical forward average but in line with what the market has generally paid for similar levels of profitability in the sector. I also want to note that Remy Cointreau has often traded at a significant premium to other European spirits companies (and staples in general) but currently trades at a modest discount; I believe this narrowed spread is reasonable given the decline in market share and the lack of growth, but a more robust outlook for FY'25 could drive some multiple expansion later in 2024.

The Bottom Line

At this point, I'd rather own another bottle of The Botanist gin than Remy Cointreau shares. I haven't heard a good plan for rebuilding market share or brand enthusiasm beyond "we're just going to wait it out", and I likewise don't have a lot of confidence in the cost reduction program. Given all of that and a valuation that still isn't all that cheap, it's not a name that I favor now, even though I do think it's worth checking in now and then as a potential turnaround/multiple re-expansion idea at some point.

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